In 2018, the U.S. economy was growing rapidly while the rest of the world was falling behind. It is becoming apparent that in 2019, the U.S. economy is beginning to feel some pressure. Fourth quarter GDP was revised down to 2.2% from 2.6% due to weaker-than-estimated consumption, government spending, and business investment as a result of the government shut-down and spillover from stock market volatility. First quarter GDP is also expected to be artificially weak because of the government shut-down and the extreme weather that occurred earlier this year. Despite the near-term risk of disappointing GDP, the economy, barring a major misstep, is still expected to expand. BBVA Research estimates that U.S. GDP growth will come in at 2.5% in 2019.
Recession fears began dominating the headlines at the end of March when the Treasury yield curve inverted for the first time since August 2007. Normally, the yield curve is upward sloping and bond investors receive higher rates on longer-term Treasuries. When the yield curve inverts, the yields on long-term Treasuries fall below those of short-term securities. Longer-term rates tend to serve as a barometer for growth expectations, which is why the inversion of the curve indicates that investors are less certain of economic growth. While an inverted yield curve has reliably predicted recessions in the past, the predictability power of the yield curve has weakened as of late, due to the yield curve’s increasing integration with the global economy. The most recent inversion was a result of several factors, including the Fed’s increasingly dovish tone, weakening economic data in Europe, and uncertainty regarding Brexit.
Moreover, the Conference Board’s Leading Economic Index (“LEI”), which has declined before the onset of each recession over the past 50 years, is sending the opposite signal to that of the yield curve. The LEI is comprised of ten economic indicators that help give economists and investors a sense of the future state of the economy. The LEI increased in February for the first time in five months, suggesting that the economy is expected to expand in the near term.
Labor market data should also ease fears regarding a slowing U.S. economy. Despite a brief pause in February, employers added a robust 196,000 jobs in March, while the unemployment rate remained unchanged at 3.8%. It is likely that February’s gain of 33,000 was a fluke – distorted by the government shutdown and extreme weather conditions. For the first quarter of 2019, job growth averaged around 180,000, confirming that the labor market continues to strengthen. The steady state of the labor force further suggests that the gains in the labor market should continue. Despite the broader demographic trend of retiring Baby Boomers, which should weigh on the labor force participation rate, the number of individuals that are currently working or actively seeking work has continued to increase - particularly for workers aged 25 to 54.
Wage growth also remains positive; hourly wages increased at an annualized rate of 3.2% in March. While it is a slight decline from February’s rate of 3.4%, wage growth is well outpacing inflation and indicates that inflationary pressures are not building. Higher wages should serve as a silver lining for workers as they boost disposable household income.
The pivot in the central bank’s policy is also evident in the actions it is taking in regards to its balance sheet. In October 2017, the Fed began shrinking its holdings by allowing $50 billion in bonds to mature each month without replacing them. However, beginning in May, the Fed will slow the monthly amount to $15 billion until October when the balance sheet runoff in Treasuries will cease. In the minutes from its March meeting, the Federal Reserve stated that it is going to be increasingly data dependent and patient before adjusting its policy stance. Potential Presidential appointees to the Federal Reserve Board have reiterated their dovish stance, which could serve to influence short-term interest rates should they be approved by Congress. It is important to note that only the Federal Open Market Committee (FOMC), which is a branch of the Federal Reserve Board, determines the direction of monetary policy. Still, the Fed has remained firm that it will continue to hold its “wait-and-see” stance that it adopted after its meeting in January. The increasingly dovish tone has occurred primarily as a result of the risks that the global economy and trade tensions have on the U.S. economy.
While the outlook for growth in the U.S. has moderated, the outlook for growth abroad has been flailing. Most recently, the International Monetary Fund cut its outlook for growth in 2019 to 3.3% from 3.5% largely due to the rise in trade tensions among various countries, contracting economies, and greater policy uncertainties abroad. Europe, in particular, has been weighing on the global economy amid deteriorating consumer and business sentiment and the lack of clarity regarding Brexit. It is likely that Europe’s consumer and business sentiment is going to struggle further amid the Trump administration’s proposal to impose $11 billion in tariffs on imports from the European Union. The European Union has agreed to launch talks for a trade pact with the U.S., but negotiators have struggled for almost a year to make progress on trade talks.
China has taken a more proactive approach to combat its economic slowdown. Chinese officials encouraged more bank lending and lowered taxes for households and corporations late in 2018. This appears to have offset some of the persistent weakness in China; as evidenced by the slight pickup in China’s manufacturing activity after China’s manufacturing PMI re-entered expansion territory in March. The service sector has also begun to pick up in China as a result of the change in its fiscal policies. Still, the state of the Chinese economy remains uncertain despite the recent positive data. BBVA Research expects the Chinese economy to grow between 6.0% to 6.5% in 2019.
Looking forward, unresolved trade tensions as as well as a potential disorderly exit of the United Kingdom from the European Union may exacerbate a slowdown in global growth and spur a decline in U.S. growth. In the U.S., growth may tick to the upside if the Fed remains dovish and a trade agreement is reached between the U.S. and China. The key question for 2019 is if the U.S. will be able to “pull-up” world growth or will the world serve to “pull-down” the U.S. economy.
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